Palm, Handspring still not ready to dance

For months, merger rumors buzzed around Palm Inc. and Handspring Inc. With the wireless computing realm in the dumps, a marriage of the ailing handheld technology firms seemed a natural.

But with no deal in the offing, industry watchers now wonder whether one or both companies could fall into the arms of a larger tech company.

“There are a whole bunch of investment bankers out there swarming around the companies trying to drum up these ideas,” said Paul Coster, senior analyst at J.P. Morgan Chase & Co. in New York. “Institutional investors desperately need their IPO recovered. Retail investors love these rumors. It’s great stuff.”

Yet both companies are adamant nothing of the sort is in the works. “We are not in any sort or any form of discussion with Palm regarding a merger,” Handspring spokesman Brian Jaquet stressed last week.

In any merger scenario, of course, there are major hurdles. For starters, any buyer of Palm faces a serious tax burden, probably in the hundreds of millions of dollars, according to analysts. That’s because when 3Com Corp. spun off Palm in 1999, 3Com obtained a ruling from the U.S. Internal Revenue Service that protects both companies from a change of ownership through July 27, 2002.

Thomas Carpenter, senior technology analyst at J.J.B. Hilliard, W.L. Lyons Inc. in Louisville, Ky., said the ruling requires both Palm and 3Com not to sign any deals that “would constitute a change of more than 50% equity interest in either company.” If Palm is sold before the end of July 2002, the acquirer and Palm would be hit with a hefty tax penalty.

Another complication: Handspring licenses Palm’s operating system software, so any company that acquires Handspring must pay royalties to Palm. “In a perfect world, you’d want people who run Handspring and their design team to be coupled with the Palm operating system,” Carpenter said.

Coster said a Palm deal for Handspring “seems to me to do nothing for shareholders.” Other analysts question how Palm would benefit from such a merger, particularly since Handspring has no operating system of its own.

A Handspring run at Palm, meanwhile, is not in the cards. Handspring has about $145 million in cash, with $90 million accessible. By the end of the year, available cash will drop to $75 million, hardly enough to buy Palm, which has a market capitalization of $2 billion.

Handspring also has amassed about $227 million in debt, according to the company’s latest quarterly report Nov. 13. It posted a loss of $32.7 million in the first fiscal quarter ending Sept. 29. Given the state of the economy, the company’s fortunes aren’t much brighter in 2002.

In addition, Handspring co-founder Jeff Hawkins, the innovator behind Palm, is said to prefer his independence, especially after signing partnerships with companies such as Aether Systems Inc., AvantGo Inc., Extended Systems Inc. and Wireless Knowledge, a subsidiary of San Diego-based wireless giant Qualcomm Inc.

Tom Sepenzis, an analyst at CIBC World Markets in San Francisco, said Hawkins might be interested in a merger with the Santa Clara, Calif., company, but can’t act on his impulses. “If there was a way for him to get it, I’m sure he’d try,” Sepenzis said. But Handspring doesn’t have the cash to buy Palm or any part of Palm.”

But what about others swooping in with bids? Certainly both companies could use some help.

Handspring, with a market cap of about $500 million, outsources its hardware manufacturing, and licenses Palm’s operating system software. Palm, which also outsources the making of its hardware, has been plagued with problems: handheld launch delays, inventory overstocks, sloppy management, bad product reviews and competition from Microsoft, which is making great strides with its upgraded Pocket PC operating system.

Both Handspring and Palm have watched their stock plummet amid sagging revenues. The two companies are also embroiled in a price war, making profitability difficult. Palm CEO Carl Yankowski announced his resignation earlier this month, causing the company’s stock to rise. That news came the day Palm said it would look to split its software and hardware units, opening the door for a spinoff or sale of its software division. Previously, the company said it would divide the two units but had no plans to spin off or sell either one.

Chahil said the company is on schedule to separate the divisions and it plans to release an integrated wireless device early next year. Handspring also announced it will begin releasing its new Treo devices, which are combination personal digital assistants and wireless phones, in January.

Of possible suitors for Palm or Handspring, Microsoft leads the pack.”There are frequent rumors about potential business deals that Microsoft might be involved in, and we have a general policy of not discussing or commenting on those rumors,” a Microsoft press officer said.

Coster questions why Microsoft would want to buy Palm. He criticized Palm’s operating system for not keeping pace with rivals, particularly with more CPU power, packet switch networks and multi-tasking features.

“I don’t believe Microsoft wants Palm,” Sepenzis adds. “They’ve spent a number of years now developing the Pocket PC and Pocket PC 2002, and quite frankly, what’s the point?” Other analysts say if Microsoft acquired Palm, Microsoft would get more than 75% of the operating system market share. Such a deal would likely raise questions among antitrust authorities.

Dresdner Kleinwort Wasserstein analyst Stephen Sweeney said in a November report that Palm can restore investor confidence by finding a strong replacement for Yankowski, but he doesn’t expect the company to turn around for several quarters. For its part, Handspring’s Jaquet would not comment on whether his company, based in Mountain View, Calif., is talking to potential buyers.